The (Postponed) End of the Dollar Era

Remember “global imbalances”? The lopsided economic relationships between exporting nations like China, Japan, Germany, and the OPEC nations on the one side and importers — mainly the U.S. — on the other were a bigtopic a coupleyearsago. Some even argued that they’d caused the financial crisis. But you don’t hear nearly as much about them now. I did a quick search on Factiva to verify this impression: 495 mentions of the phrase “global imbalances” in the first three months of 2009; 175 mentions in the first three months of this year.

Part of the explanation for the reduced attention is reduced imbalances: The U.S. current account deficit, which measures the gap between what the country takes in from export income, investment income, and cash transfers and what it pays out, peaked at nearly 6% of GDP in 2006 and was down to 3.1% of GDP in 2011.

Still, 3.1% is a big shortfall — one that takes hundreds of billions of dollars of new foreign capital every year to finance — and the gap shows no signs of shrinking further. So why does hardly anyone seem worried about it? I would bet it’s mainly a case of limited attention: global imbalances haven’t caused any obvious problems over the past three years, so investors, policy makers, business decision-makers, and financial journalists have turned their attention to other matters, such as Europe’s struggle to deal with its own regional trade imbalances. Not to mention that Brad Setser, who for years did more than anyone to keep attention focused on global capital flows in the U.S., traded blogging for a job in the Obama administration in 2009 and hasn’t been heard from since. The issue, and the danger, are still there. We’ve just had other things to think about.

That this blithe disregard for global imbalances just can’t go on forever is a thought that kept returning to me as I read Philip Coggan’s fascinating new book, Paper Promises: Debt, Money, and the New World Order. Coggan is the Buttonwood columnist for the Economist and used to write the Short View and Long View columns for the FT (he was also my neighbor when I lived in London just over a decade ago). The book is a little hard to sum up: its cast of characters ranges from Dionysius of Syracuse to Ben Bernanke (both practioners of quantitative easing), and its author is both studiously nonideological and unwilling to pretend that we know more about the workings of the global economy than we do. At one point Coggan states that “if there is a fundamental theme of this book, it is that there are no easy answers in economics.”

He’s selling the book a little short there; another fundamental theme is that no global currency arrangement can last forever — because imbalances eventually build up that cannot be sustained. In the current dollar-dominated system the problem is what’s known as the Triffin dilemma: when a nation’s currency serves as the global reserve currency, that nation inevitably runs current account deficits to enable its currency to circulate abroad. And at a certain point those deficits grow too big to be sustained, and confidence in that currency declines.

That’s been the case with the dollar for a while. With the exception of a significant uptick during and immediately after the financial crisis, when scared investors the world over reflexively poured their cash into U.S. Treasuries, the dollar has been on a downward trend in international currency markets since 2002. But it has stayed the global currency because there’s no alternative. The Euro’s continued existence is uncertain, and China is years away from making its currency freely convertible in global markets and decades (at the least) from convincing global businesses and investors that they’d be safe keeping their cash in yuan.

It’s because of this lack of a replacement that Coggan calls the debate about when the dollar will cede its status as global currency “a bit of a red herring.” Long before that becomes a real possibility, he writes, we may confront a drastically changed global financial landscape where capital flows are restricted and the U.S. has terms imposed on it by creditor nations such as China. It won’t quite be the end of the dollar era. But it will be the end of the remarkably free-wheeling era in global finance and U.S. budgetary policy that began in the 1970s.

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